9.2. Bonds

Question 1

Issuers

Answer 1

• Government
• Corporate
• Local authority/municipal bonds
• Foreign [in local/foreign currency]
• Other types of bespoke issuers

Question 2

SYSTEM T

Answer 2

S- Govt bonds are risk (default) free. Other issuers carry more risk
Y- Yield to maturity known/varies by issuer/nominal vs real
S- Depends on bond term/duration
T- Varies from short to long-dated and irredeemable
E- Depends on bid-offer spread & marketability (depends on issuer)
M- Usually good for govt bonds [varies/lower for corporate bonds]
T- Income and capital gains tax

Question 3

Yield curve theories

Answer 3

Expectations theory:
Shape is determined by expectation of future short-term interest rates
Liquidity preference:
Investors prefer liquid assets&raquo_space;> upward sloping pressures
Inflation risk premium theory:
Higher yield for long dated bonds&raquo_space;> upward sloping pressures
Market segmentation:
S&D is investor/term dependent

Question 4

Reasons why actual returns < GRY

Answer 4

 Reinvestment of coupons may not occur at GRY
 Default by issuer
 Rand return on overseas bond affected by currency movements
 Inflation means real return =/= to GRY
 Dealing costs
 Issuer exercises call option against investor
 Tax [unless tax exempt, but withholding tax on overseas bond may be payable]

Question 5

Reducing the risk in corp bonds

Answer 5

Less risk if lower default risk. Could be result of:

• Type of debt, i.e. higher-ranking debt (e.g. debentures)
• Existence of fixed/floating charges
• Higher levels of income/capital cover
• Restrictions on further corporate borrowing
• Lack of prior ranking debt
• Parent company guarantees if loan is issued by subsidiary
• 3rd party guarantees e.g. insurance
• Securitisation
• Shorter term issue.